Monday, August 9, 2010

The Fed: To QE or not to QE?

We all know what the right answer is here.  The math is simple.  The problem is the Fed feels the heat from there buddies on Wall St who badly want to see more stimulus.

The right thing to do of course is to not even consider another QE.  There are many risks and "unintended consequences" of pulling the QE trigger for a second time(more on this later).

Goldman was out with a report this weekend(hat tip to zero hedge) claiming that a second $1 trillion QE is imminent.

The Ponzi boys on Wall St love this idea of course:

"The Fed will likely leave its federal funds rate near zero, but the central bank could signal plans to restart some programs such as its purchase of mortgage-backed securities or buy Treasury bonds. The central bank's programs ended earlier this year when it appeared the recovery was proceeding well.

"The Fed has a lot of tools in its tool shed," said Larry Rosenthal, president of Financial Planning Services in Manassas, Va. "They have to bring buyers back into the market; they have to bring consumption back into the market."

My Take:

The reality here is Rosenthal's comments couldn't be further from the truth.  The Fed is just about out of tools with rates sitting at zero.  The Fed cannot bring consumption back to the market because the consumer is tapped out.

The consumer no longer have the ability or the desire to borrow anymore.  They are over leveraged and worn out.  If the consumer's mortgage payment isn't wiping them out than his/her child's $40,000 a year college bill is.  If that's not hitting them then their credit cards or Ponzi car payment most assuredly are.

The Fed must face the reality that the US just finished the largest spending binge ever seen on planet earth.  Trying to force more debt down there throats will not work!

In order for a consumption economy to work the consumer must have the ability and willingness to borrow.   Right now we have neither because the consumer is up to it's eyeballs in debt. 

The only answer to this problem is to allow the consumer to deleverage via paying off debt or defaulting on it.  This process is going to take several years if not a decade and the Fed HAS to start accepting this. 

How many bailouts will it take before they realize this is not working?  We have fiscallythrown everything but the kitchen sink at this economy and it has done nothing but tank in the process. 

Unemployment is soaring despite what the government statistics are telling you.  The unemployment rate stayed flat at 9.5% but what they fail to tell you is 180,000 workers ran out of UE benefits and fell out of the statistics last month.   We are closing in on 20% U6 unemployment.  I expect us to be there by the end of the year.

The reality here folks is the Fed could do a $5 trillion QE and it wouldn't matter because none of the money would end up in the real economy because no one has the ability to borrow it. 

As a result of the inability of it to flow into the real economy, the money would likely start flowing into other assets which would create even more distortions in things like commodities and treasuries. 

This could be devastating from a commodities perspective because it could push the cost of things like food and oil up sharply.  The money has to go somewhere right?  If it can't go into your pockets it's going to end up somewhere else.

The trading desks would have a field day in such an environment like they did in early 2008 when they pushed oil to $150 a barrel.

The Bottom Line

I suggest that the Fed ask themselves the following questions before deciding to take this reckless QE path:

Does going the QE route instantly make us a target as the world chooses austerity while we continue to spend like drunken sailors? 

How will the $2 trillion FX market react to such reckless policy?  Does the dollar get destroyed as we become the last keynesians on the planet?

What happens if the bond market rejects this idea and starts pushing rates higher?

There are other questions but I will stop there. 

The bottom line here is all the Fed will be doing is kicking the can a little further down the road if they decide to do another QE.

Japan basically attempted QE from 2002-2006 and accomplished nothing.

The Fed knows this won't work.  They saw what happened in Japan. 

However, that doesn't mean they won't pull the QE trigger.  In fact, I fully expect them to do so. 


All you need to do is ask yourself who wins with a QE policy?  The bankers of course!  A QE would help them keep the status quo which if FINE by them.

Today's environment doesn't get any better if you are a banker:

You have zero interest rates which is a gift that keeps on giving.  This gives the banks the opportunity to make a killing on bonds as they borrow at zero from the Fed and then buy the long dated bonds.

I laugh when people suggest that we need more stimulus money via QE in order to stimulate lending. 

The banks could care less if they dont have any borrowers.  Who in the heck needs borrowers? They could care less if they lent anyone another nickel.

They are making a fortune by playing the bond game that I explained above.  They alos don't have to take the losses on their bad loans in this current environment which makes the current situation even more beautiful for them.

Life is basically perfect for a banker right now and they have no desire to lend to you althought they would never admit it of course.

Think about it:

Why would the banks want to take on a bunch of risk by lending to a bunch of borrowers who facing the worst economy since The Great Depression!  The only loans they are interested in doing right now are ones that are backed by you the taxpayer via the government.  This is why just about ever home loan goes through FHA now.

The system is perfect for the pigmen and the idea of having the Fed sit on the sidelines without easing and risking an all out collapse is not acceptable.

This is why I fully suspect that you will see a QE2 at some point.  I also expect to see a QE 3,4, and 5 too.  Extend and pretend has been the policy all along.  Why should we believe this will change anytime soon?

I don't know if the Fed will pull the trigger tomorrow.  They may very well wait for more data before pressing the QE button.  The market will likely sell off if the Fed doesn't announce at least some type of easing program IMO.

I fully expect some type of announcement of assistance from the Fed.  Whether or not it will be a QE is debatable.    

If a QE is announced we will see how the bond market reacts, and it will be easy to see how they feel because the government is selling a boatload of long term treasuries this week.

Disclosure:  No new positions taken at the time of publication.


getyourselfconnected said...

hey Jeff!

Wow, our posts tonight could have been companion pieces! Great minds think alike, I hope, HA!

I think the FED will be quiet tomorrow, better to surprise later than telegraph tomorrow.

Jeff said...


I'll have to check it out. Just got home.

Yeah I am guessing they might save it for when the market rolls over again.

If Goldman and the boys are really pressing it might happen tomorrow.

Should be interesting to watch!

getyourselfconnected said...

Thanks for swinging by.

I have to email you a story from a few weeks ago, you are gonna love it!

Jeff said...

Send it!

Wow Futes down pretty hard.


Hmmm....A dovish Fed perhaps?